First Block Capital Inc. (“First Block”), an
investment fund manager based in Vancouver, British Columbia, was granted
registration pursuant to National Instrument 31-103 —Registration Requirements,
Exemptions and Ongoing Registrant Obligations in the categories of “investment
fund manager” and “exempt market dealer” in British Columbia and Ontario, with
the BCSC acting as the principal regulator. The registrations were granted to
allow First Block to operate an investment fund that will invest exclusively in
bitcoin.

BLG represented First Block with a team led by
Jason Brooks that included Rob Wallis in relation to the registration
application, and Carol Derk, Craig Webster (Tax), Grace Pereira (Tax), Whitney
Bell and Inaki Gomez in relation to First Block's bitcoin investment fund.

The terms and conditions of registration
imposed on First Block by the BCSC allow First Block to operate under the
current securities regulatory framework while providing securities regulators
with the opportunity to continue to assess the potential risks associated with
this type of investment vehicle.

The registration approval by the BCSC signals a
general willingness by Canadian securities regulators to respond and adapt to
the fast-developing asset class of cryptocurrencies.

Regulatory Guidance for Cryptocurrency Market Participants

The registration of First Block followed very
closely on the heels of the publication by the Canadian Securities
Administrators (the “CSA”) of CSA Staff Notice 46-307 — Cryptocurrency
Offerings (the “Notice”), which provided the CSA’s guidance on the application
of securities laws to cryptocurrencies and investment funds that invest in
cryptocurrencies. In the Notice, the CSA acknowledges that cryptocurrency
offerings provide businesses with an innovative method to raise capital and for
investors to access a new asset class, but maintains that entities must
consider all relevant securities laws when engaging in an offering of
cryptocurrencies or the sale of securities of a cryptocurrency investment fund.
In the Notice, the CSA confirmed the following:

• prospectus and registration requirements
under securities laws may apply to the distribution or trading of a
cryptocurrency that constitutes a “security”;

• an investment fund established to invest in cryptocurrency
or crypto-assets must comply with prospectus and registration requirements, as
well as anti-money laundering and know-your-client requirements; and

• cryptocurrency exchanges may be considered
marketplaces under Canadian securities laws and may be subject to regulation.

For a complete discussion of the Notice, please
see our previous publication: CSA Increases Regulatory Clarity in the Cryptic
World of Digital Currencies.

Practical Considerations for Cryptocurrency Offerings

Canadian securities regulators are sensitive to
the interest in obtaining investment exposure to cryptocurrencies and appear to
be cautiously balancing their mandate of protecting the public and the
integrity of the capital markets with the need to enable new innovative forms
of investment. Firms that plan to offer cryptocurrencies or baskets of
cryptocurrencies should ensure that they consider and address the following
unique issues:

• Registration
– All cryptocurrency market participants — exchanges offering a trading platform
for cryptocurrency, dealers offering an over-the-counter trading solution for
cryptocurrency, firms advising on the merits of cryptocurrency or seeking to
develop algorithms to navigate the market, and managers of any cryptocurrency
fund — have to consider the applicable registration requirements, including
dealer, adviser and investment fund manager registration, and should carefully
consider which categories of registration are required in light of their
service offering, investment and distribution strategy or product structure,
how the product will be sold and whether the cryptocurrency assets held are
considered “securities”. Of note, it is now clear that even a fund that invests
solely in bitcoin or another cryptocurrency is considered to be an “investment
fund” and, therefore, require a registered investment fund manager.

• Product
development and structuring – Cryptocurrency market participants also have
to consider how the product development, distribution and structure of the
cryptocurrency offering impacts the regulatory analysis and whether the
utilization of cryptocurrency derivatives is appropriate to achieve the optimal
structure.

• Risk
and relationship disclosures – Market participants are required to
carefully consider the appropriate disclosure to provide to clients or
investors on cryptocurrency and to tailor the disclosure to address not only
the specific risks of the particular cryptocurrencies and the proposed trading
or investment strategy, but also the risks associated with the blockchain, the
Bitcoin network, security breaches, the loss or destruction of private keys,
relationships with service providers, business continuity and the rise of other
digital assets.

• Due
diligence – To date, cryptocurrency exchanges are largely unregulated and
their operations may not be transparent. As a result, securities regulators
require managers of cryptocurrency funds to undertake reasonable due diligence
on any proposed cryptocurrency exchange, including an analysis of its policies
and procedures for identity verification, anti-money laundering,
counter-terrorist financing and recordkeeping. Cryptocurrency fund managers
should be prepared to address exchange trading volumes and the impact volumes
may have on the ability to meet redemption requests.

• Internal
controls and cybersecurity – Given the potential risks associated with the
open-source structure of a cryptocurrency exchange, securities regulators
expect cryptocurrency market participants to implement internal cybersecurity
risk management programs, risk management systems, and business continuity
plans designed to prevent cyber incidents and to limit any loss or liability
associated with cyber incidents.

• Valuation
– Cryptocurrency fund managers must establish appropriate policies and procedures
for valuing the securities of their funds and the underlying cryptocurrency
assets.

• Custodianship
– In granting registration to any new cryptocurrency fund manager or allowing
an existing manager to expand into this area, securities regulators will very
likely prescribe specific requirements for the custody of all cryptocurrency
assets and expect these cryptocurrency custodians to have expertise that is
relevant to holding cryptocurrencies, including experience with “hot” and
“cold” storage and security measures to keep cryptocurrency assets protected
from theft.

It is clear that the regulators expect any new
or existing fund manager that wishes to establish a cryptocurrency investment
fund or to expand the mandate of their existing funds into cryptocurrency
investments to reach out to their principal regulator in advance to discuss the
details of their plans and how the above issues and other relevant issues will
be addressed. Although the CSA has shown a willingness to be flexible in their
approach to the application of the existing securities regulatory framework in
this area, managers should expect that the regulators will continue to engage
in a very thorough and thoughtful review of the related regulatory and investor
protection issues.

The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.

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